Musings on the world around

“I went skydivingI went Rocky Mountain climbingI went 2.7 seconds on a bull named Fu Man ChuAnd I loved deeperAnd I spoke sweeterAnd I gave forgiveness I’d been denying…

Someday I hope you get the chanceTo live like you were dying” — Tim McGraw

It really wasn’t that long ago that the then-named Apple Computer stared into the abyss. Faced with declining market share for its Macintosh computers, an archaic operating system and the very real possibility that it might not make it to the millennium, Apple went and bought Steve Jobs software / hardware startup Next in 1996, bringing back the company co-founder. Next’s software became the foundation of the MacOS that’s still in use today, Jobs took a series of bet-the-company gambles on a funky new computer (the 1998 iMac), company-owned retail stores that most people considered an idea certain to fail, a pricey music player (the 2001 iPod), a shift to Intel chips, a touchscreen phone that would eventually kill most of an MP3-player market Apple controlled 70-percent of, and so on.

When Jobs rejoined Apple, the company’s balance sheet was sufficiently thin that Jobs asked his old friend and rival Bill Gates to have Microsoft invest $150 million in Apple to help shore it up and inspire confidence in the company. But make no mistake, Apple was on thin ice. They’d nearly been acquired by Sun prior to the Next acquisition and sales had been falling for three years.

Apple had to jump on the orneriest bull at the rodeo over and over because it had no real alternatives. Management had to run the company like that Tim McGraw song. The subsequent decade that would end with the iPhone, which would beget the iPad, would turn the company into the most valuable one in the world. It has also swelled the balance sheet to a holder of $100 billion in cash that’s barely earning any interest. And that cash horde is currently growing by about $10 billion per quarter.

There are elements of the Apple blogosphere and fandom that believe this situation is fine. “Apple knows best” they say. And certainly, there is some logic to that given the results of current management. Further, Apple uses its cash strategically, to pre-buy billion in components for example, allowing it somewhat unprecedented flexibility in the consumer-electronics business. But even with all of its strategic uses, Apple has more cash than it knows what to do with. And it has said so, which brings us to today’s announcement of a $2.65 per share quarterly dividend and a $10 billion stock buyback over the next 3 years.

It’s worth dissecting each of these individually, because they really represent different uses of Apple’s cash horde, signal different things, and in no way represent the kind of sky-is-falling nonsense that was delivered today by several “experts”, including Rob Enderle, of the eponymous Enderle Group. His breathless proclamation, “That’s a company that’s thinking tactically and it means they don’t know what to do with their money and I think that’s trouble in the long term.” Let’s revisit that nonsensical notion in a moment.

First, the dividend. At $2.65/share per quarter, that’s $10.60 annually for an approximately 1.8% dividend yield. In other words, Apple stock now currently will earn you more cash than most CDs with 3-year maturities or shorter. This is actually lower than the S&P average of 2.2%, but an infinite increase over the zero dividends Apple has been paying out for the past 17 years. Last year, Apple added $40 billion in cash and equivalents to its balance sheet. That alone would cover the dividend for more than the next three years.

Second, the stock buyback. At $10 billion, Apple could retire about 17 million shares given the current share price, representing less than 2% of the shares outstanding. Apple says this is to cover stock issuances due to options and employee stock purchase plans, restricted stock units, etc. And, really, the point is inarguable. A lot of stock buybacks are performed by companies without much earnings growth and are designed to retire large quantities of the outstanding share pool to boost earnings per share when cash flow is strong but the stock isn’t. Apple isn’t one of those companies. A lot of announced share buybacks never get completed for any number of reasons, but if Apple does complete this one, it will cost the company less than $1 billion per quarter over the announced 3-year period.

There’s a really good series of arguments around share buybacks. They generally don’t succeed in boosting stock prices nearly as much as hoped, for example. And, as Netflix shareholders can tell you, companies suck incredibly badly at judging the value of their own stock price. Netflix was buying back stock at $200+ share last year and then selling it to investors for under $80 recently! But Apple’s buyback is actually the best kind. It tacitly acknowledges that handing out stock to employees in whatever form is a real cost to the company and it uses the company’s cash to buy back enough stock to make the various stock grants, option exercises, etc. possible. This protects shareholders from the dilution associated with all that new stock and is the kind of thing all mature companies should be doing.

The size of the buyback seems a bit shy in that the shares outstanding has grown by roughly 30 million over the past two years and — assuming today’s share price — Apple will only retire half that many shares over the next three. Obviously, if the stock gets cheaper, Apple will be able to buy back more shares, but correspondingly if the stock rises to $1000 over the next two years, very few shares will disappear.

But let’s focus on what this signals. It doesn’t, as Enderle and others would have you believe, signal some kind of trouble ahead. In fact, I’d argue it’s the opposite. Apple is currently accumulating cash at a faster rate than these two programs will pay it out. The 3-year total cost of the dividend and buyback might well be covered in the current year alone! That means, as Horace Deidu at Asymco points out, Apple’s cash will continue to grow, albeit more slowly. By putting into place the two standard mechanisms for returning cash to shareholders, Apple also sets itself up to avoid the temptations to (a) become ridiculously conservative or (b) do something insane that you can only do with, say, $100 billion to burn.

As concerns conservatism, Om Malik of GigaOm wanted Apple to sit on its cash. ”I, for one, believe the company should just sit on the cash and not worry too much about Wall Street just yet. It is important that they use the cash to lock up supplies of components for its products. The cash cushion gives the company room to actively compete for talent as well as any future startups it might need to acquire to enhance its overall ambitions.” And 77% of his readers agree in an informal poll. What? Apple already secures components in unprecedented ways with its cash, pre-buying components, locking up supply of what it considers critical, blocking the competition from getting it. It was doing this $80 billion ago too. Even a much bigger Apple in, say, 2013 can’t possibly deploy tens of billions more than it already uses for this purpose.

As for securing talent, Apple already pays well, is growing headcount and can’t ever pay enough to, say, discourage someone looking for a tech-startup IPO payday. The notion that the company should keep billions around to overpay people to join the company or stay there is bizarre. And, well, the acquisitions argument is nonsense. Apple has no track record of even spending $1 billion on an acquisition. Fortunately, it could still wake up and spend $10 billion tomorrow without risking much of anything besides reputation and management focus. If Apple wanted to do the kinds of talent-acquisition buyouts that, say, Facebook does, it could affordable thousands of them. It could also do the equivalent of Google’s big three (YouTube, Doubleclick, Motorola Mobility) without, again, putting the balance sheet in any jeopardy.

What you should be afraid of is not that Apple can no longer buy Twitter (it can), but a decision to buy Twitter. It would be so out of character with anything Apple had ever done and such a bizarre, ill-fit for the company. Twitter is terrific, but really there is no synergy there and owning Twitter doesn’t enhance any of Apple’s other long-term goals in the iTunes/movies/media universe, the device universe, the post-PC universe, or really any universe. I don’t mean to single out Twitter either. It would be terrifying if Apple bought AMD or Sharp or Disney either. On the other hand, if Apple bought Spotify or Netflix to expand its media offerings, those would be uncharacteristically large buys, but not completely disjointed from Apple’s long-term mission as a content distributor.

There has been much talk of Apple trying to offer a better television experience to offer alongside their putative Apple LCD TV. It should be a relief that the company continues to pursue this idea without pursuing something insane like acquiring Comcast. Holding on to 100% of the cash coming in and letting it grow to, say $200 billion would have made a cash purchase of all but about 20 companies on earth possible while still leaving more cash on the balance sheet than all but about 10 companies globally.

No doubt Jobs’ legacy of fearing the worst played a role in waiting till the cash pile had reached $100 billion before deciding what to do. And until Jobs passed, the board of directors probably didn’t want to go to war with him over this. But it had become a problem and the solution to that problem began Monday. When you have enough cash to fund years of losses, you run real risks of not reacting to bad times. “We don’t need to lay anyone off this year even though we lost $20 billion, we still have $100 billion in the bank.” “We can build these overly pricey products since we can afford to subsidize losses on them for years to come.”

That kind of thinking is not what brought Apple to its peak today. It was making tough choices about what not to do, about what initiatives to give up on, about how to make its products cost competitive so they can rule entire markets (can any Tier 1 company compete with the iPad’s price/features yet?).

Someday, Apple’s growth is going to return to more normal levels from the stratospheric heights it sits at today. When? Well they’ve defied gravity for so long it seems a fool’s errand to guess that date. But the day will come in the next few years. At that point, the company will have a track record as a dividend payer that will put more of the shares in the hands of the patient and fewer in the hands of the “hot money” types that are more worried about next quarter than next decade. This is the kind of transition that Apple fans should be delighted by instead of frightened about. In the meantime, the kind of caution that says, “We can produce one new phone a year and grow our market share very nicely thank you” was in evidence today with a small dividend and really small buyback announcement. The Apple Jobs returned to, the nearly bankrupt one, is long gone. Long live Apple, one of the world’s greatest legal cash-generating machines.

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One Response to Apple’s cash: Too much of a good thing, isn’t

Hi there- good post. One thing to consider is that inestvors don’t necessarily have to decide between buying now or waiting. A lot of long-term inestvors ignore the use of options, but long-term income inestvors can gain a lot by using them. For example, right now, PEP is at $66.31/share. You can sell July 10th calls for $204 which obligates you to buy 100 shares at $65 if the stock price dips below $65 during the timeframe. This means that you get 204/6500 = over 3% of your investment back in premiums, and then you’ll be obligated to buy at $65 if the buyer decides. Or you can sell July 10th calls at a strike price of $62.50, but receive a premium of only $131 (2% of your investment). The point is, if you want to own the stock but want it at a little lower price, you can sell an option to make income on your money and then either own the stock in the future at the price you wanted, or if the options expire, you can sell more options.